Don’t Go Variable Because Rates Are “Overextended”

The worst trap a mortgage expert can fall into is thinking they’re shrewd enough to predict interest rates.

Yet, they do it because they:

  • Think they’re smarter than the market
  • Want media, readers or clients to think they’re smarter than the market
  • Are completely delusional.

The most comedic rate commentators are the ones who couch their predictions in vagaries so people can’t pin them when they’re wrong.

Instead of saying “rates will go down,” for example, they’ll say something like “rates are overextended.”

What does that even mean? How overextended are they? When will they become un-overextended? Why are they overextended?

These “gurus” would have you believe that traders are misreading the fundamentals. Yet they, in all their banker, analyst or mortgage broker wisdom, can see through the noise and discern the path of rates—despite the infinite random economic events that could alter rate fundamentals overnight.

The beauty about saying rates are “overextended” is that the “expert’s” prediction can’t be readily discredited. Even if rates keep climbing, the expert’s excuse for being wrong is that the bond market is temporarily “oversold” and must eventually retrace.

Heros Get Their Heads Handed to Them

In 1972 inflation dipped below 3%, a welcomed break from the hefty price increases of the prior five years. The Federal Reserve, as reputable an expert as any, predicted that “inflation should gradually dissipate over a period of four or five years.”

A mortgagor taking cues from the Fed back then might have very well chosen a short-term fixed or variable on that prediction. After all, the Fed has as much economic data and foresight as anyone.

That would have been a mistake.

One year later, inflation hit double digits and rates skyrocketed five points.

The Moral

You may hear people like us talk about structural disinflation and mega trends that should keep inflation (and rates) below current historical averages over the long run. But always remember that at any given time, markets can do what none of us ever expected.

Inflation from an overstimulated economy and spiralling federal debt (like what might be brewing south of the border) can put dread in the hearts of seasoned investors, and when seasoned investors get scared they sell bonds…fast. That drives up rates quicker than a pack of dogs drives a cat up a tree.

This by no means suggests that rates could imminently soar. It’s simply a reminder that if you’re vulnerable to higher interest costs, don’t bite on the lowest variable rates just because you see “Prime – 1.00%!” in newspaper headlines…or because some mortgage broker was quoted saying rates are overextended.



7 Comments

  • BC Ratespy Reader says:

    What kind of fool uses Vietnam War time as an example?

    Alright, let’s say you had a crystal ball to lock a 5-year fixed mortgage in 1972 for 2.5%. What are you gonna do in 1977 for a refinance at 9% prime rate? How about 5 more years later – 1982 at 17% prime??

    Those days are long gone. People made a living by holding saving accounts with over 10% interest back then. nowadays? QE1, QE2, QE3, until QE99 for any moderate financial crisis.

    Take P-1 before it’s gone.

    • The Spy says:

      The same kind of fool who imposes a 200-basis point national stress test on well qualified borrowers with 20%+ equity?

      The same kind of fool who could have used dozens of examples throughout history to make the same point about not outguessing the market?

      The same kind of fool who understands that rates don’t need to hit 9% or 17% to cause mortgage ruin for hundreds of thousands of Canadians?

      The same kind of fool who knows that bond vigilantes make governments pay for runaway deficits and “99” rounds of printed money?

      The same kind of fool who understands that risk exposure varies by borrower, and that mortgage terms are not one-size-fits-all?

      Yours foolishly,

      The Spy

  • Lazyboy Economist says:

    The US has $174,000 of debt per US taxpayer and counting. In 1980 it was $11,323. http://www.usdebtclock.org/

    Anyone who thinks this is sustainable and will never inflate interest rates better think again.

  • Dave says:

    Prime – 1% isn’t going anywhere. Some of the banks may end their promotions this month but you’ll still be able to get this rate for weeks or months to come.

  • MJ says:

    Talk sense to a fool and he calls you foolish.

  • Don says:

    Is this “P-1%” scenario, currently playing out, not a part of the Big Banks’ overall marketing strategy? That is, the banks thrive operating in an environment where consumers are very often confused by the “talking heads” in the media, each bank has at least one high level self serving economist. Let’s get the confused masses in the door, with the “P-1%” and then do the “bait and switch” manoeuver once variable rates inch higher and once there are no other viable options. I can hear them now “Oh, so sad your variable rate is high… we have a fixed rate product for you ( @ a not so favourable rate!) and we’ll waive your penalties.”

    Banks make the majority of their profits on penalties/ threat of penalties when mortgages are broken. Spreads are less of a cash grab.

    Thoughts anyone? Self servers need not apply!

    • The Spy says:

      I do love a good conspiracy theory.

      Here’s what we know. Big banks model profitability based on potential mid-term refis, conversions, etc. They know people will break, increase and/or lock-in before maturity. And their rates for these existing customers are rarely as good as their best discretionary rates. Hence, fatter interest margins and more $$$ for the beloved shareholder. While this isn’t the only factor behind the banks’ current variable-rate strategies, it’s certainly one factor.

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